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Saturday, November 08, 2008

Stock Market vs Control System

As an Engineer by training, I like to analyze systems, especially Control system. There are some similar characteristics and differences between a typical control system and stock market.

Similarities
1. Both response to inputs to produce an output response. A typical control system will react to changes in input to produce an output response. Similarly, stock markets will react from external factors (i.e. inputs) to produce a response (i.e. market can move up, down or range).

2. Both can be compensated. A typical control system can be compensated if the output is unstable. Similarly, the stock market can be "compensated" with some good news if there are bad news all around which causes markets to drop.

3. Control system can be unstable. Stock markets can also be unstable, as panic selling can causes all methods of analysis (fundamental, technical etc) to be thrown out of window.

4. Control system can reach steady state. Similarly, markets can reach "steady state" if it moves out of its unstable state. Compensation can also help the markets to move out of unstable state.

Differences
1. Control system can be modelled easily but stock markets cannot. Because control system are feedback (i.e. closed loop) or open loop system, it can be modelled. Stock market is an adoptive system but not exactly a closed loop system and therefore it is difficult (if not impossible) to model such a system. Because stock markets are difficult to model, they are not easily "controlled" and therefore hard to do exact compensation to get the desired output. That makes "guessing" short term market movements difficult.

2. Control system can be controlled by using compensator and controllers. One can minimize error in design by having system modelling and deciding on the controllers/compensator used. Stock markets are unpredictable in short term. It is difficult to do exact compensation to get the desired output effect. In fact, it can even make things worse if the wrong compensator is used. Even if the right compensator is used, the stock market might not produce the desired response.

3. If we design a control system with all the requirements and conditions met, systems will still fail due to unforseen circumstances. As for the stock market, there are too many unforseen circumstances which makes hindsight investing the only sure-win "system design".

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17 Comments:

Blogger ZhuKoLiang said...

Hi, i m newbie George from sgfunds and i m an Electronic Engr Student in NTU now... i truly agree with what u say...

3:24 PM  
Blogger ghchua said...

Hi ZhuKoLiang,

So how's life now in NTU? Exam over already?

6:37 PM  
Blogger ZhuKoLiang said...

yo, now my exams r ongoing... sometimes i pop in to see your blog / sgfunds posting...

A control system needs "Damping factor". To analyse a control system, need to use "Laplace Transform"... muahahahhaa...

I wonder if we can analyse the stock market using Laplace transform or fourier series... Seriously, i have thought of that, by inputting the stock prices into a software which computes out the frequency domain of the Stock Price.

Interesting????

8:11 AM  
Blogger ghchua said...

Hi newbie_george,

In order to analyze any system mathematically using Laplace, Fourier etc, we must first be able to model it.

Unfortunately, I find it difficult (if not impossible) to model the stock market. However, I do find the stock market similar to a control system in the sense that it can be overdamped (sluggish market), underdamped (market overshoot) or critically damped (market just nice).

8:54 PM  
Blogger Jess said...

ghchua,

I believe you are really out of control by saying all these and using control system as analogy...

it really show that you do not understand the market at all...

It will be determentrial if investor are going to adopt your system or believe your analogy...

6:17 AM  
Blogger ghchua said...

Hi jess,

A control system is similar to the stock market, though there are differences as highlighted by me in the posting. A stock market is similar to a control system as it exhibits some of the similarities that I have stated.

If a stock market cannot be controlled, it can be unstable. If you believe that the stock market cannot be controlled at all, then you should wish that your doomsday situation will come soon.

6:28 PM  
Blogger Jess said...

ghchua,

I really think you are getting crazy... There are so many economic models that are being used to predict the market conditions... I believe Fed have many of this too so that they can predict the economic conditon and make forcast..

why do you want to bring out control system analogy just because you have studied it? I hope that the recent sell off don't affect you at all for making such nonsense comparison...

2:36 AM  
Blogger ZhuKoLiang said...

hi jess,

itz ok la...

lets respect each other's view in the internet.

u can agree.
u can disagree.

u can discuss why u agree/disagree.
BUT dun scold the person crazy or insult him

FOr me, i am also (i think) proficient in the fundamentals of control system with damping factor and using laplace transform to analyse it in the freqeuncy domain. i can agree with ghchua.

ghchua is far more veteran than me .. he is like level9 in stock market, while i level1.

ghchua is NTU EEE Electronic graduate years ago, while i m only studying now...

u know what is veteran? haha...

itz ok la.. =)

2:47 AM  
Blogger ghchua said...

Hi jess,

Keep your options open. Just because Fed is using economic models doesn't mean that other models cannot be used on the stock market. Engineering concepts are applicable in finance. You just have to appreciate these concepts and understand them in order to apply it.

What I have said here is not new. In fact, there are various studies available out there. Just an example:

Stock Predictor Algorithm: A Control Method Dealing With Distributed Control Systems
Yefii Wang; Yi Shen

Summary:An algorithm called the stock predictor algorithm is designed in this paper. It can be used in distributed control systems which have these characteristics: (1) it contains lots of sub-systems. (2)Every sub-system could be controlled using a predicted value. (3) Within a certain sub-system, it will not do much harm to the whole system even if the predicted value differs greatly from the actual value. (4) The sub-system could be non-linear, time-dependent, but it will not change quickly. The stock predictor algorithm described in this paper used a method similar to the way used by the stock-holders towards the stock predictors in the stock market. It applied several different control algorithms (viewed as stock predictors) to every controlled object (sub-systems) in every circle. Within each sub-system, according to the historical precision of every stock predictor, we use a weighted average value as the preferred predict value of that sub system. Then, when the cycle comes to an end, the stock predictors update their algorithms according to the difference between the predicted value and the actual value. Based on this algorithm, we applied the stock predictor algorithm on a heating system, and got an optimized control strategy which is proved to be both efficient and economical.
http://ieeexplore.ieee.org/Xplore/login.jsp?url=/iel5/4052642/4052643/04052693.pdf?isnumber=4052643&prod=CNF&arnumber=4052693&arSt=49&ared=49&arAuthor=Yefu+Wang%3B+Yi+Shen

6:06 AM  
Blogger ghchua said...

Hi newbie_george,

Control Engineering concepts are applicable in a lot of stuff. Biomedical field is one example of using control concepts in order to treat patients. I hope that you can keep your mind open and explore Engineering concepts to apply them in other applications.

6:13 AM  
Blogger Kris said...

This comment has been removed by the author.

2:15 AM  
Blogger Kris said...

An Engineer will alway be an engineer :P

2:16 AM  
Blogger ghchua said...

Hi Kris,

True and False. :) An Engineer can remain as an Engineer, if he/she chooses to be so. Having said that, Engineers are versatile and they can certainly switch fields and use their Engineering knowledge to apply into other stuff.

Engineers are analytical, which means the skill set is relevant in other areas. Though we might not have the technical knowledge in other areas, we can pick it up quickly as our Engineering knowledge enable us to be able to understand and solve problems, which is why we are employed in the first place.

So, though I am an Engineer by training, I am interested in other areas which might not be Engineering in nature. Stuff like investing, financial planning etc.

7:44 PM  
Blogger edragon said...

Hi ghchua,
I agree with you though engineering is a more precise science since it do not involve emotions like it is in the stock market. It is this emotions like confidence OR the lack of it that make the market erratic.

8:00 PM  
Blogger Mike Dirnt said...

just something to comment.

an engineer can do a financing job. but a financer cannot do and will not understand an engineering job

9:47 PM  
Blogger jesus antonio muñoz cuellar said...

human behavior is part of nature and the equations attempt to describe nature.
  so the market is based on human behavior... model it should be possible

8:50 PM  
Blogger ghchua said...

Hi jesus antonio muñoz cuellar,

Thanks for your comment. I do agree with you but many people are not able to understand the application of Engineering concepts in finance. I suspect that if all problems in finance can be solved by equations, then it will be much more easy! :)

10:14 PM  

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